Place for comments on "Keynesian Parables of Thrift and Hoarding"

This is not really a blog post; it's an experiment. I have no idea if it will work, but the downside costs seem trivial.

If you subscribe to Review of Keynesian Economics, or if your university has a subscription, you can read my article "Keynesian Parables of Thrift and Hoarding". (Anyone can read the abstract and get the gist.) If you want to comment on that article, here is your chance to do so.

[OK, that was the blog post. But it seems to me that one of the problems with academic articles is that the reader doesn't get a chance to comment on the article, and the author doesn't get the chance to read readers' comments and respond to them. So if you want that opportunity, here is your chance to comment, and my chance to reply to your comment. It's an experiment to see if there might be some complementarity between articles and blogs.

And thanks to Matias Vernengo and Louis-Philippe Rochon for the invitation to a non- (or sorta-) Keynesian to submit an article to ROKE. They wanted contributions from "the other side" too (see Simon Wren-Lewis's article too). So I tried to write a sort of "internal" critique of Keynesianism.]

Comments

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I only looked at the abstract, but it seems hard to distinguish "thrift" from "hoarding".

From a finance perspective (which should be equivalent to what is embedded in DSGE models), you first decide how much you save, then decide how to allocate your portfolio (cash/bonds) You can largely decouple those decisions since the efficient market hypothesis tells you that expected returns should be the expected path of the overnight rate. (The savings allocation presumably affects that path, but presumably a second order effect). I do not see this as radically different in implication from what post-Keynesians say (at least the MMT/SFC wing), although this may not match highly simplified economic models.

"Hoarding" as a "dash for cash" during a crisis is a different beast (and a "bad thing"), but that is a fairly short-lived phenomenon. It would be possible to explain "secular stagnation" as the result of excessive thrift, but not a "dash for cash". However, the collapse in activity in 2008 could be viewed as a "dash for cash". Whether DSGE macro explains a "dash for cash" probably depends upon your point of view; certainly pre-2008 models would have had a hard time with it.

There's no question that Keynes appreciated the distinction between thrift and hoarding:

GT Chapter 9

"The rise in the rate of interest might induce us to save more, if our incomes were unchanged. But if the higher rate of interest retards investment, our incomes will not, and cannot, be unchanged. They must necessarily fall, until the declining capacity to save has sufficiently offset the stimulus to save given by the higher rate of interest. The more virtuous we are, the more determinedly thrifty, the more obstinately orthodox in our national and personal finance, the more our incomes will have to fall when interest rises relatively to the marginal efficiency of capital. Obstinacy can bring only a penalty and no reward. For the result is inevitable."

GT Chapter 13

“The concept of hoarding may be regarded as a first approximation to the concept of liquidity-preference. Indeed if we were to substitute ‘propensity to hoard’ for ‘hoarding’, it would come to substantially the same thing. But if we mean by ‘hoarding’ an actual increase in cash-holding, it is an incomplete idea — and seriously misleading if it causes us to think of ‘hoarding’ and ‘not-hoarding’ as simple alternatives. For the decision to hoard is not taken absolutely or without regard to the advantages offered for parting with liquidity; — it results from a balancing of advantages, and we have, therefore, to know what lies in the other scale. Moreover it is impossible for the actual amount of hoarding to change as a result of decisions on the part of the public, so long as we mean by ‘hoarding’ the actual holding of cash. For the amount of hoarding must be equal to the quantity of money (or — on some definitions — to the quantity of money minus what is required to satisfy the transactions-motive); and the quantity of money is not determined by the public. All that the propensity of the public towards hoarding can achieve is to determine the rate of interest at which the aggregate desire to hoard becomes equal to the available cash. The habit of overlooking the relation of the rate of interest to hoarding may be a part of the explanation why interest has been usually regarded as the reward of not-spending, whereas in fact it is the reward of not-hoarding.”

Being the supreme macro-accountant (the first one really), he would be totally in tune with the general stock/flow consistency theme of the post-Keynesians.

Hoarding is a stock/asset allocation of liquidity, interconnected with the determination of the interest rate, as he notes above. He correctly rejected the idea of the interest rate as being determined by an "equilibrium" of saving and investment. He maintained correctly that those two measures are continuously equivalent.

Recession dynamics are a flow phenomenon as he describes it, using reconciliation of income accounting at two different points in time.

The behavior of liquidity, hoarding, and the interest rate is stock behavior (including hoarding) within that saving flow dynamic (including thrift).

I see money as a tool. Economic activity is enhanced when the tool (money) is used. But there is no economic requirement that economic tools be used; the tool (money) can be stored in the shed, unused. This is hoarding of the monetary tool.

On the other hand, thrift is a lifestyle of judicious economic activity. But what does "judicious" mean? One extreme might be living-off-the-land completely avoiding monetary (the tool) involvement. Another extreme might be maximum utility of monetary exchange where a miles-walk-to-save-a-penny may set the standard. To me, "thrift" speaks to the concept of "excessive demand for money" (or lack thereof).

I think there is a third economic activity, in addition to thrift and hoarding. This third activity is the action of creating the monetary tool (money). The presence of this third activity allows one economic partner to create (he creates the money tool) at the same time that a second economic partner hoards (he puts the tools into the shed for storage).

In my opinion, the effects of this third economic activity (the creation of money) are under-appreciated.

Brian: when finance people (or accountants) talk about "cash", they mean something different from what I mean. They normally mean something like "safe (in nominal terms) financial assets with a term of less than one year". I mean "medium of exchange". To the individual it may make little difference; but for the economy as a whole it makes a big difference. We need to watch out for fallacies of composition.

JKH: Keynes was aware of the distinction, but was unaware of the *importance* of the distinction. You can only see this in Chapter 23:

“The idea behind stamped money is sound. It is, indeed, possible that means might be found to apply it in practice on a modest scale. But there are many difficulties that Gesell did not face. In particular, he was unaware that money was not unique in having a liquidity-premium attached to it. But differed only in degree from many other articles, deriving its importance from having a greater liquidity-premium than any other article. Thus if currency notes were to be deprived of their liquidity-premium by the stamping system, a long series of substitutes would step into their shoes – bank-money, debts at call, foreign money, jewelry and the precious metals generally, and so forth. As I have mentioned above, there have been times when it was probably the craving for the ownership of land, independently of its yield, which served to keep up the rate of interest; -- though under Gesell’s system this possibility would have been eliminated by land nationalisation.” (General Theory, pp 357-8)

Keynes is wrong. Gesell was right. There is only a difference in degree for the individual, but a difference in kind for the economy as a whole. Medium of exchange is a system property.

Your article presents a real difference between the physical sciences and economics – or at least some economics. No one cares what Einstein thought about anything. It's just not part of the current scientific debate. We have relativity and we go forward. No one reads his original papers (unless you're interested in the history of science).

Whether Keynes misunderstood something or not I don't think is part of any serious issue in economics. These are not the questions of our time.

The DSGE models I am aware of have "money" (whatever that corresponds to in the real world) which is typically non-interest bearing, versus 1-period Treasury bills (but there are variations). Since the core assumption of mainstream macro is that households are optimizing, the natural solution is for the household to hold no money. Therefore, there is either a "cash-in-advance" constraint baked into the model, or a demand for money slapped into the utility function. The household solves its optimization problem, respecting the new constraints, which will generate non-zero money holdings.

However, for any plausible parameters, the "demand for money" is largely a fixed component of the household's portfolio, and changes in savings rates will have limited impact on money holdings. (This obviously depends on how money enters the utility function.)

For example, if we assume a cash-in-advance constraint (which is based on the nominal volume of economic activity), and the solution is somehow perturbed to induce more savings and output falls in the first time period, the amount of money held would actually drop (in the first period) in the new solution.I find it hard to interpret that outcome as the result of an increasing demand for money.

This largely looks like how a finance portfolio optimization is set up, or the portfolio allocation decisions within the SFC models of Tobin and Godley. I can't comment on the rest of the post-Keynesian literature; I know that there are strenuous objections to the concept of optimizing households in some quarters.

As for the concept of a "medium of exchange", I would need to translate that into more concrete terms and think about it. From a modelling standpoint, it seems to me that this implies that "money" in a theoretical model is not easily mapped into particular monetary aggregates; we need to take into account institutional factors. Seems reasonable.

I don't see anything in the Keynes quote that contradicts this, unless I understand the term system property incorrectly. His point seems to be that that system property is not confined to a specific asset class and will pop up in other assets if the (in this case monetary) costs of holding the official medium of exchange outweigh the (in this case non-monetary) benefits. Which is another way of saying money is an endogenous phenomenon, rather than being solely and exclusively a function of CB fiat.

Avon: the whole point of that issue of ROKE was to be an 80 year retrospective on Keynes' General Theory. It *was* History of Economic Thought, and in the broad sense, which includes the relationship between past and present economic theory. And if a physicist were asked to do a retrospective on Einstein, and thought that Einstein had made a mistake, and that same mistake had pervaded modern physics because of Einstein's influence, I think he would be quoting Einstein.

Brian: "For example, if we assume a cash-in-advance constraint (which is based on the nominal volume of economic activity), and the solution is somehow perturbed to induce more savings and output falls in the first time period,..."

The point of my article was to argue that an increase in *thrift* could not cause a recessionary fall in output (unless it caused an increase in hoarding as a by-product).

"... the amount of money held would actually drop (in the first period) in the new solution.I find it hard to interpret that outcome as the result of an increasing demand for money."

If there is an increased desire to hoard, that will cause a drop in output, but if the demand for money falls as a consequence of that fall in output, and so prevents further hoarding, that is precisely what prevents output falling to zero.

Frances: I can't figure out if it's kosher. It's not like it was a working paper subsequently sent off to a journal.

Tom: it would be interesting to see what Avon makes of Jason.

Oliver: if Keynes was saying that a Gesellian tax would cause people to switch to using (e.g.) land as a medium of exchange, that would indeed be very different. But I'm pretty sure that is not what he meant.

Once again, I would note that I did not read your article. would interpret "thrift" as an increased aggregate propensity to save. Within a SFC model, that would cause a rise in inventories, and probably a drop in fixed investment (unless the desire to invest also rose to match). An increase in a demand for money would just be a portfolio shift, and would not have much of an impact on activity.

I get that classical economists do not buy the drop in aggregate demand story. But in order to for the macro flows to balance, it seems that you would have to assume that increases in savings will match desired investment, so that there is no retrenchment of activity. From my perspective, it looks like you are lumping any mismatch in desired savings and desired investment as the result of "hoarding". Although interesting, it seems plausible to imagine a forced increase in savings (which is unmatched by investment plans) that has nothing to do with the demand for money.

The distinction mentioned in this paper is key, especially in the current world.

I wonder if the reason Keynes didn't put enough emphasis on it was that it was less relevant to the economic situation he lived in.

The current wave of near retirees, the global "savings glut", and the potential technological innovation slowdown, means that aggregate demand shortfalls may more efficiently be solved through increases in net aggregate investment instead of increases in final immediate consumption. Things like loans and equity are precursors to net investment. Idle money, not so much.

We live in a world where the dependency ratio is rising and where we have a large cohort expecting to reduce work while maintaining consumption. This means that the economy should physically be building, while the labor is still available, long term assets and business infrastructure that will allow it to continue increasing production for a decade or two with relatively less labor.

Brian: I am definitely not arguing the "classical" line here. An increase in desired *hoarding* will cause the failuer of Says Law and a fall in AD.

I was trying to figure out if there was a typo in your last sentence. It would be a better critique if it read: "Although interesting, it seems [IM]plausible to imagine a forced increase in savings (which is unmatched by investment plans) that has nothing to do with the demand for money."

In the article, I consider an increased desire to save ("thift") in the form of land.

Benoit: Interesting. Yes, I don't think the aging boomers story (where you have *temporarily* higher saving) would have been central to his thoughts.

Nick:
"I was trying to figure out if there was a typo in your last sentence. It would be a better critique if it read: "Although interesting, it seems [IM]plausible to imagine a forced increase in savings (which is unmatched by investment plans) that has nothing to do with the demand for money.""

The example I have in mind would be a massive increase in the mandatory CPP contributions. For the sake of argument assume that 100% of those contributions are invested in private sector financial assets, so this could be viewed as being equivalent to a forced investment into private sector (non-money market) funds. Assume that aggregate saving rises by 3% of GDP (which is presumably less than the size of the contribution contribution increase, since one would assume that the CPP increase might lower other savings). I would argue that this is going to end up being pretty much equivalent to a tax hike of 3% of GDP, and reduces growth by [insert Keynesian multiplier analysis here]. However, would not Say's Law suggest that the effect is minimal, that is, the "multiplier" is effectively zero?

Nick:
"In the article, I consider an increased desire to save ("thrift") in the form of land."

I have not attempted to wrap my head around land in this context. Land is a real asset, and might have a relationship to the real quantities in a utility function. Most saving is in the form of the purchase of financial assets, and the assets are just viewed as a claim on future cash flows. The expected return is driving the saving decision, not the type of asset.

Brian: thinking about land is actually simpler. Because there's an immediate answer to the question: "If everyone tries to buy more land, where does the extra land come from?". Answer: "It doesn't; they can't" (leaving aside the Dutch). So what happens next, when people find they are unable to buy more land?

There is only ONE way for an individual to increase his stock of land: buy more land. And the individual cannot do that unless he finds a willing seller of land, so he is stuck if everyone is trying to do the same thing.

There are always TWO ways for an individual to increase his stock of money: buy more money (i.e. sell more other goods); sell less money (i.e. buy less other goods). He can't buy more money unless he can find a willing seller of money, so he is stuck if everyone is trying to do the same thing. But nobody can stop him selling less money. So we get a recession.

That is why the medium of exchange is totally different from all other assets. There's always TWO ways to get more. Because money circulates, and flows both into and out of our pockets, whenever we sell or buy *anything* else (including non-money financial assets).

If you have increased mandatory CPP contributions in private sector financial assets, where do those extra private sector financial assets come from?

"And if a physicist were asked to do a retrospective on Einstein, and thought that Einstein had made a mistake, and that same mistake had pervaded modern physics because of Einstein's influence, I think he would be quoting Einstein."

No Nick, this is not how science works. If there was a mistake in Einstein's ideas, we would be talking about the experiment that revealed it. No one would care what Einstein might have thought about the experiment today if he were still alive. If after 80 years people are still going on about what Keynes might have meant, when he didn't interpret right, etc., then as a scientist I say there is no content. Discussion will be nothing more than a pointless exercise of how many angels dance on the head of a pin. Nothing will ever resolve the debate, even in principle.

But econ is a science and there are interesting and important questions being asked. There is great work out there. None of it has anything to do with what Keynes may or may not have thought about something.

As David Levine puts it:

"Economists have worked for decades trying to make sense of Keynes theory and use it to explain the facts about depressions, recessions, crises, unemployment and so forth. It is hardly the case that a conservative profession dismissed Keynes and refused to take him seriously, that the economics profession never gave him a fair shot. Quite the opposite: some of the most brilliant minds in the profession convinced of the absolute truth of Keynes ideas spent decades trying to make those ideas work - they and we have failed.

Knowledge of Keynesianism and Keynesian models is even deeper for the great Nobel Prize winners who pioneered modern macroeconomics - a macroeconomics with people who buy and sell things, who save and invest - Robert Lucas, Edward Prescott, and Thomas Sargent among others. They also grew up with Keynesian theory as orthodoxy - more so than I. And we rejected Keynesianism because it doesn't work not because of some aesthetic sense that the theory is insufficiently elegant.

Keynes own work consists of amusing anecdotes and misleading stories. Keynesianism as argued by people such as Paul Krugman and Brad DeLong is a theory without people either rational or irrational, a theory of graphs pulled largely out of thin air, a series of predictions that are hopelessly wrong - together with the vain hope that they can be put right if only the curves in the graphs can be twisted in the right direction. As it happens we have developed much better theories - theories that do explain many facts, theories that provide sensible policy guidance, theories that work reasonably well, theories that are not an illusion. The current versions of these theories are very unlike caricature theories of hopelessly rational people who are all identical. Current theories are not perfect - but unlike the Keynesian theory of perpetual motion machines they explain a great deal and have a great deal of truth to them."

“I argue that Keynes missed seeing the importance of the distinction between saving in the form of money (‘hoarding’) and saving in all other forms (‘thrift’).”

I think that premise is wrong.

It is stock/flow inconsistent in the post Keynesian sense.

The form of macroeconomic saving is investment. That is according to Keynes’ definition of saving – income not consumed, and the necessary equivalence of saving and investment at all times.

To suggest that saving breaks down into money and non-money “forms” contradicts that framework.

First, money does not enter into it at the macroeconomic level, because all saving is accounted for by investment, and investment as defined is never money. Second, “thrift” is a loose descriptor of the propensity to save. It is not a sub-category of saving and it is not a form of saving. The only “form” of saving at the macroeconomic level is real investment. All of the intermediation at the microeconomic level – involving money and other financial assets – cancels out. There is no net addition to macroeconomic saving provided by financial assets.

In the quote I provided above, he says that “not hoarding” includes preferences for other forms of liquidity, which is how the interest rate is determined.

So “not hoarding” does not necessarily mean spending instead of hoarding. That is his point. And if it doesn’t involve spending, then it can’t be a systemic determinant of recessions.

Conversely, you define hoarding as “saving in the form of money”. That must mean that you would define “saving in all other forms” as “not hoarding”. But that is the distinction that he identified as erroneous in that quote above. So when you say that Keynes didn’t understand the importance of that distinction, perhaps it is because he rejected the way in which you have defined the distinction itself.

I would see the following types of mechanisms which allow for "demand destruction".
- money is exchanged for equities whose market value rises (from existing owners) , who reallocate into other financial assets (triggering a wave of other transactions), or "hoard" the money. (I guess I can see your point now about hoarding, but nothing has changed in the demand curve for money; we just have a new asset allocation with higher money holdings.)
- slowdown of economy creates larger government deficits via automatic stabilizers (taxes, EI), which increases supply of gov't debt.
- Corporations issue paper to finance their inventory build. Although this is investment, it is involuntary, and would lead to planned shutdowns of capacity.
- corporations issue debt, so that they can retire more shares, triggering the same revaluation response.

The following would reduce demand destruction (lowering the multiplier)
- Corps issue paper to undertake new investment
- sellers of assets that went up in price go on a spending spree.

Ramanan: I left a comment on your blog (I think) but it doesn't appear.

Sure, if desired saving and desired investment increase at the same time, by the same amount, (we switch from demanding consumption goods to demanding investment goods like new houses), there will be no fall in AD. There's no disagreement between me and Keynesians there. So I'm looking for a case where there could be disagreement. And land seems to me to be a nice simple example, where we can explore exactly what types of saving would or would not cause a fall in AD.

Roger: it takes two volunteers to tango. Both buyer and seller must agree to the trade, or there is no trade. We call this "the short-side rule". Quantity actually traded = min{quantity demanded; quantity supplied}. (And "quantity supplied" means "quantity they *want to* sell.)

CORRECTION: The line "One of the other providers of the MUST step forward (or not step forward) to take ownership." should read "One of the other providers of the THREE SERVICES MUST step forward (or not step forward) to take ownership.

First, I realised I forgot the most important possibility in this context.

The model central bank is following something like a Taylor Rule, and keeps the interest rate on Treasury bills at the level suggested by that rule. [I hope that transactions in the money markets are not enough to cause large divergences in the target interest rate for the period.]

Then, let's assume that the CPP wants to allocate away from "money" towards "Treasury bills". We assume that other investors have investors have a "portfolio allocation function" (for example T-Bill holdings versus cash, depending upon the rate of interest). The price of Treasury Bills will drop until it reaches a point where the market clears; this might require central bank selling of T-bills in order to hit its "Taylor Rule" target. [Note that this is the logic of standard DSGE macro, which sort of fit the per-2008 system in the U.S.; might not match the Canadian system.] It is possible that the entire CPP buying of T-bills is met with central bank selling; no other "private" investor will have changed their money holdings.

Equities will follow the same logic, but we would have to have a more complex investor portfolio allocation function, such as in the models of Tobin and the Godley/Lavoie. The complication is that central banks are not supposed to target equity prices, and they generally do not have any on their balance sheets. If all other investors were determined to keep their equity holdings constant, the CPP would have no choice but to solely invest in the T-Bill market. However, that does not seem to reflect rampant equity turnover.

And *all* markets are "money markets" (if barter is not possible), so let's stop using that word to describe the market where IOUs are traded for money. Call it "the IOU market". Just like we call the market where apples are traded for money "the apple market".

In that economy, I would have to modify my usual usage of "financial assets" to be "financial assets and real estate".

If *everyone* wants to increase their land holdings unconditionally, and that we assume everyone has the same endowment, there's no way the market can clear, and there's no model solution. If there is going to be a solution, all that can happen is that the price of land goes up until a *conditional* land demand function is brought into balance with the new set of relative prices. Since everyone has a more valuable real estate portfolio (measured in money units), they can go off shopping for services. The optimal solution would be to keep everybody employed at the same level. Basically, nothing happens other than a relative price shift. Interesting, but I think a Keynesian should scream bloody murder about the restrictive assumption about the endowments.

In order to get interesting behaviour, I think you need to have different households in different positions, and so we can get a reshuffling of portfolios. I think you end up with the equivalent of the case of CPP buying equity from existing holders, with "land" replacing "equity". The effect on the labour market depends upon the seller's reaction - do they hold cash, or spend it on services? I would interpret the problem as being the increased savings into "financial assets and real estate", as the "hoarding" by the seller was not the result of a change of behaviour, rather it was a (fixed) reaction to a relative price shift.

Brian: "The effect on the labour market depends upon the seller's reaction - do they hold cash, or spend it on services?"

Yep. If you can't buy land, or if the price of land rises until you stop wanting to buy land, we only get a recession if they decide they want to hold extra money instead.

But (I think) you get my point about money being different, because of the two ways to get extra money?

I don't think we need assume everyone has the same endowment of land. And we could replace "land" with "IOU's". Or replace it with "both land and IOUs". Or replace it with "everything *except* the medium of exchange".

Nick: "There is only ONE way for an individual to increase his stock of land: buy more land. And the individual cannot do that unless he finds a willing seller of land, so he is stuck if everyone is trying to do the same thing.

There are always TWO ways for an individual to increase his stock of money: buy more money (i.e. sell more other goods); sell less money (i.e. buy less other goods). He can't buy more money unless he can find a willing seller of money, so he is stuck if everyone is trying to do the same thing. But nobody can stop him selling less money. So we get a recession."

Not quite sure that really explains an important distinction between land and money. No one can increase his stock of money by selling less because if all do exactly the same he will end up with the same amount as before. Same as with land when he cannot find a willing seller; everyone will just end up with the same amount as before. There are differences in liquidity and the type of goods/services money and land get exchanged for. Plus, money is the liability tied to expiring IOUs, land is not.

... Krugman mentions an Euler equation. The Euler equation essentially says that an agent must be indifferent between consuming one more unit today on the one hand and saving that unit and consuming in the future on the other if utility is maximized.

So there are agents in both formulations preferring one state of the world relative to others.

Odie: "No one can increase his stock of money by selling less because if all do exactly the same he will end up with the same amount as before."

Yes. I am aware of that. That's the whole point. It's a Prisoners' Dilemma. But nobody can stop each individual selling less money. Taking others' actions as given, each individual increases his stock of money by selling less money. But collectively they succeed in selling less money but fail to increase their stocks of money.

I did not mean to suggest you do not know that point. I merely wanted to illustrate that there are two ways for someone to try to increase their holding of money and land: 'Buy more' or 'sell less'. In this regard they seem to me indistinguishable.

"This is false. The L in ISLM means liquidity preference and e.g. here"

I know what ISLM is. It's not recursive so it really doesn't have people in it. The dynamics are not set by any micro-foundation. If you'd like to see models with people in them, try Ljungqvist and Sargent, Recursive Macroeconomic Theory.

In effect you are saying that if households and corporates decrease their 'current' spending (or consumption), this needn't - contra Keynes - be deflationary provided that they are prepared to buy capital goods instead. I'm sure this is right (although I'm not conversant enough with Keynes to know if he denied this).

But if the private sector is feeling thrifty and therefore cutting back on their current spending, how realistic is it that they will simply switch (any meaningful portion of) that decrease in spending over to buying capital goods, either in aggregate or individually?

Is there an actual historical period you have in mind where the private sector seemed to do this - ie ramped up the proportion of its capital spending in a way which preserved the NGDP trajectory, whilst feeling concerned about the future?

Anders: Keynes would not have denied that (I'm pretty sure). But I am saying something stronger than that. Newly-produced capital goods are only one of many things they could be wanting to buy instead. Land is just one example.

So the definition of "people" is restricted to agents making multi-period optimizations over time, solving a dynamic programming problem?

Well then any such theory is obviously wrong because people don't behave that way. For example, humans don't optimize the dictator game. How can you add up optimizing agents and get a result that is true for non-optimizing agents ... coincident with the details of the optimizing agents mattering.

Your microfoundation requirement is like saying the ideal gas law doesn't have any atoms in it. And it doesn't! It is an aggregate property of individual "agents" that don't have properties like temperature or pressure (or even volume in a meaningful sense). Atoms optimize entropy, but not out of any preferences.

So how do you know for a fact that macro properties like inflation or interest rates are directly related to agent optimizations? Maybe inflation is like temperature -- it doesn't exist for individuals and is only a property of economics in aggregate.

These questions are not answered definitively, and they'd have to be to enforce a requirement for microfoundations ... or a particular way of solving the problem.

Are quarks important to nuclear physics? Not really -- it's all pions and nucleons. Emergent degrees of freedom. Sure, you can calculate pion scattering from QCD lattice calculations (quark and gluon DoF), but it doesn't give an empirically better result than chiral perturbation theory (pion DoF) that ignores the microfoundations (QCD).

Assuming quarks are required to solve nuclear physics problems would have been a giant step backwards.

The microfoundation of nuclear physics and quarks is quantum mechanics and quantum field theory. How the degrees of freedom reorganize under the renormalization group flow, what effective field theory results is an empirical question. Keynesian economics is worse that useless. It's wrong empirically, it has no theoretical foundation, it has no laws. It has no microfoundation. No serious grad school has taught Keynesian economics in nearly 40 years.

If I put together an NJL model, there is no requirement that the scalar field condensate be composed of quark-antiquark pairs. In fact, the basic idea was used for Cooper pairs as a model of superconductivity. Same macro theory; different microfoundations. And that is a general problem with microfoundations -- different microfoundations can lead to the same macro theory, so which one is right?

First, ISLM analysis does not hold empirically. It just doesn't work. That's why we ended up with the macro revolution of the 70s and 80s. Keynesian economics ignores intertemporal budget constraints, it violates Ricardian equivalence. It's just not the way the world works. People might not solve dynamic programs to set their consumption path, but at least these models include a future which people plan over. These models work far better than Keynesian ISLM reasoning.

As for chiral perturbation theory and the approximate chiral symmetries of QCD, I am not making the case that NJL models requires QCD. NJL is an effective field theory so it comes from something else. That something else happens to be QCD. It could have been something else, that's an empirical question. The microfoundation I'm talking about with theories like NJL is QFT and the symmetries of the vacuum, not the short distance physics that might be responsible for it. The microfoundation here is about the basic laws, the principles.

ISLM and Keynesian economics has none of this. There is no principle. The microfoundation of modern macro is not about increasing the degrees of freedom to model every person in the economy on some short distance scale, it is about building the basic principles from consistent economic laws that we find in microeconomics.

I just looked up your thesis - very nice! I was a phenomenologist once too, but in the high energy world - mostly SUSY GUTs, but some cosmology (dark matter), and extra dimensions. Like you, I moved into industry - quant work. I spend my time mostly with rather exotic stochastic processes now, which I find much more fun.

I find economics fascinating, but the minds of the macro revolution are very, very bright. There are some very deep waters there and that is why I had to work out the details in Ljungqvist and Sargent and the like for myself. These ideas go way beyond the MC Escher drawings that Keynes paints.

BTW, when you were at Washington, did you ever take a course from David Kaplan? His notes on effective field theory are super sweet!

Avon, clearly you and Jason can carry on a conversation over [some of?... well, at least one of] our heads. If you digested his thesis, then this (his econ paper) should be a breeze (shoot, even I can understand it! Plus he's as gracious as Nick at answering questions).

Then you're observing that if households and corporates decrease their 'current' spending (or consumption), this needn't be deflationary provided that, instead, they are prepared to maintain their spending but divert it to EITHER newly-produced capital goods OR buy pre-existing real investment goods such as land.

My concern on newly-produced capital goods is that in practice I can't imagine any CFO telling its board "I'm worried about the future - so let's ramp up our capex". I don't see why the same doesn't apply to real investibles. If the board is concerned about the future, won't it fear land values falling?

We also need to consider who is selling the investible: presumably someone with lots of assets - a rich household or a fund, perhaps. If there is increased net selling of real investibles by this group to the group which has cut back on its current spending (corporates and / or ordinary households), we have to ask what the investible-sellers do with the proceeds. If they use it to boost their own current spending, then you're absolutely right that spending will have been smoothed. But it seems much less likely that the investible-sellers should be increasing their spending by decreasing their endowments, than that they are selling because they fear investment values may fall and would prefer to hold cash.

It seems to me that for your insight here to hold true, you need bearishness amongst part of the economy to be accompanied by (a) an inclination for the bears to express this fear in a curious way (by buying assets, not accumulating cash), and / or (b) there to be an equal and opposite level of bullishness elsewhere in the economy (with asset-owners opting to dis-save). I can't envisage such a scenario ever arising. It also seems decidedly different from the generalised bearishness which Keynes envisaged.

> My concern on newly-produced capital goods is that in practice I can't imagine any CFO telling its board "I'm worried about the future - so let's ramp up our capex". I don't see why the same doesn't apply to real investibles. If the board is concerned about the future, won't it fear land values falling?

Distinguish the short-term and long-term futures, where in the long-term things return to "normal."

Nobody says "I think the world's going to end soon, so I'm going to go get that graduate degree," but plenty of people say "I think the job market sucks right now because of a recession, so I'm going to go get that graduate degree." Investment in human capital (by way of education) increases because of a recession.

Your graduate degree example is absolutely fair, inasmuch as you identify a cohort of people who would ramp up their dissaving in the face of generalised bearishness. This increased dissaving will indeed offset increased saving elsewhere. I can think of other examples: as the recession starts, restructuring advisors and distressed debt funds will invest in hiring new employees initially at a loss, in order to build up a platform and franchise for when the restructuring opportunity emerges.

If there were many analogues to this in sufficient other groups of people (including workers for whom further training wouldn't be appropriate or available) and in other corporate sectors, then I think Nick's point would hold. But these examples seem rather niche relative to the overall economy, no?

If you boil Keynes down to one contribution, it was surely to draw attention to the fallacy of composition. Doesn't your conception of orientating macro firmly in the "consistent economic laws that we find in microeconomics" miss this point? Or do you repudiate the FoC?

Anders:Then you're observing that if households and corporates decrease their 'current' spending (or consumption), this needn't be deflationary provided that, instead, they are prepared to maintain their spending but divert it to EITHER newly-produced capital goods OR buy pre-existing real investment goods such as land.

My concern on newly-produced capital goods...

My concern would be entirely with spending on pre-existing assets insofar it is GDP neutral (land may be a bit special in this sense, I haven't quite decided yet). No macroeconomic value is added by shuffling savings.

Our year, we self-organized our quantum field theory class and ended up with several professors giving lectures, including David Kaplan. He was also in the INT and our group's brown bag seminars. If you are referring to this:

http://arxiv.org/abs/nucl-th/0510023

... I probably had seen some early versions in that class. But I graduated in 2005, so the nice typeset version came out a bit late for me.

My friends were on the short range gravity experiment that generated quite a bit of excitement when they were testing the possibility of large extra dimensions.

Anyway -- I think models like ISLM may be "effective theories" in certain regimes (e.g. it does fail when inflation is high). I'm trying to make sense of econ (for myself, at least) from an effective theory viewpoint.